Venture Capital

Are you really sure that you want to go this route? Most entrepreneurs who pursue venture capital don’t qualify and merely end up wasting a lot of time and energy in a futile endeavor.

It gets worse, a venture capital firm will in most cases fire the founder and founding team within months of an early financing round. The Wall Street Journal pointed this out in a article by Barnaby Federer from September 30th, 2002:

“If you ask a VC what value they add, and you get
them after a few drinks, they’ll say, ‘We replace the CEO’ “,
he said. And that, he indicated, does not vary
with the economic climate.

10 Reasons to Shy Away from Venture Capital

Venture Capital a Faustian Bargain

“We’re going to raise venture capital!” – Rookie Entrepreneur

This declaration is heard daily across the land from first-time entrepreneurs. To the uninitiated it sounds impressive and even glamorous to embark on such a path. However, to veteran entrepreneurs it’s a strong indication of the rookie’s naivety and lack of understanding of the consequences of accepting money from outsiders.

While venture capital can be a tremendous boon to a tiny fraction of the companies pursuing it, in the vast majority of cases it presents the entrepreneur with a “Faustian Bargain.” Venture capital brings with it tremendous meddling and pressure from venture capitalists who in this day and age typically lack both the operating and industry depth of their predecessors. The effect of this on fledgling ventures is loss of control by the entrepreneur which then frequently leads to bad–and sometimes fatal–business decisions being made.

Here are ten drawbacks of venture capital for the entrepreneur to mull over before making a decision to pursue it.

The decision to chase venture capital is often a tempting distraction from the much more complex and important entrepreneurial tasks of creating something to sell and persuading someone to buy it. The pursuit of venture capital is sometimes a means by which to postpone the day of reckoning when the marketplace finally decides if the idea will fly.

Venture capitalists behave like sheep investing only in whatever industry happens to be the flavor of the month. Everyone else need not apply.

Rookie entrepreneurs talking to venture capitalists expose their ideas to increased risk because they cannot distinguish between genuine interest and mere “brain-sucking” to uncover corporate secrets.

Once negotiations begin venture capitalists will typically stall in order to push cash short companies to the brink of bankruptcy as a way of extracting additional equity and concessions at the last moment.

Terms demanded by greedy venture capitalists frequently work to erode and ultimately destroy the founding team’s motivation and commitment to building a successful company.

With the first dollar of venture capital accepted the entrepreneur’s control slips away to 28-year-old MBA wonder-boys with only the shallowest of operating experience.

As soon as venture capitalists become involved the founder’s role shifts from critical company building functions to preparing reports, attending endless meetings, writing memos, and hand-holding impatient and/or meddlesome investors.

An infusion of capital often shifts the founding team’s focus away from selling to spending money in an effort to placate venture capitalists who often confuse bulking-up staff and assets with real growth.

Venture capital brings with it tremendous pressure to create a liquidity event but this frequently results in bad decisions being made to launch products too early or enter into the wrong markets.

The venture capitalist’s knee-jerk response to every problem faced by a portfolio company is to fire the founders and evade any personal responsibility for bad decisions.

Here’s a bonus 11th reason why venture capital is bad. It is by far the most expensive money an entrepreneur can ever tap into. Let’s do the math to see why this is. Suppose you and a venture capitalist agree to a “pre-money” valuation of $1 million for your start-up, and the venture capitalist then invests $1 million for 50% of the equity. After the investment, the company is said to have a “post-money” valuation of $2 million. Being 50/50 partners sounds acceptable, right?

Three years later the company is sold to a Fortune 500 corporation for $5 million. Do you and the venture capitalist each get $2.5 million from the proceeds? Not on your Nellie! The venture capitalist will have a so-called “liquidation preference” built into the original investment agreement which allows him to first take out 2 to 5 (or more) times his principal before anyone else sees a penny. So, let’s say that in this example he takes out $3 million (i.e., a “3X liquidation preference”), plus any accrued dividends on his preferred stock. After exercising the liquidation preference and cashing in his dividends only $1 million is left. You, the founder, and your team, will then split this remaining money on a 50/50 basis with the venture capitalist.

This is a simplified example of what happens.In real life the founder and her team would probably receive far less than even the $500,000 due to all the fine print clauses.

At this point, you really have to ask yourself if it’s even worth the effort.

The good news is that there is a wealth of academic research to support the contention that anyone wishing to build a company for the long term will be better off by not utilizing venture capital. As a result savvy entrepreneurs devise startup strategies that allow them to focus on generating cash flow during the first year instead of chasing venture capital. Conversely, naive “entrepreneurial wanna-bees,” such as those we observed in the dotcom era, have a philosophy which can be summed up as, “Give me X million dollars or this idea is dead!”.

If your entrepreneurial goal is a company “built to last” it’s usually best to forgo venture capital. On the other hand, if your goal is a company “built to flip” for a fast buck use venture capital if it is available to you.

Peter Ireland, is an entrepreneur, former CEO of a public company, and angel investor.

Copyrights 1996-2003 Peter Ireland All Rights Reserved. If you wish to reprint the above article, please do so in its entirety and include author contact information.

Thanks for your words of wisdom. I have a idea. The idea has been proven to work. I have a business plan. I have passion. I don’t have friends and family with money that can back me. What do I do? Are angel investors better?

Here is a great idea- why not stop stomping on peoples dreams to better themselves, and get a real job
rather than your poor attempt to discourage the world, if Edison and Einstein and Franklyn had listened to people like you the world would still be in the dark ages, why not just find the hole you came from and go back,
I’m sure the darkness is your best image. Now if you really want to help people why not start a venture group that actually has a team of people who can evaluate from a napkin art and have enough brains to see if it fills a need to the public- and maybe we could get jobs from these products which -Oh My God ! turn the economy around!! Wow who would think that inventions supported by venture capital could help American jobs ? With all your reasons why people should not do something- why not find some reasons for people to do something-
??? It just can’t happen with people who believe they know everything,is the air thin up there ? To anyone who reads this- Don’t stop dreaming- don’t stop trying- one step in front of the other and a journey is made, no one has the right to stop some ones hopes and goals. Prove them all wrong and make it real. And 30% is more like it for a partner, the greedy need not apply- and the only thing said correct – protect, protect , protect your ideas -before you present. I’m a 25 years professional inventor who has an open door with over 5,000 toy manufacturers, and licensed ideas since 1994. I have patents on twelve products, and over 4,000 inventions.
Startup funding is around $60 k to make a foundation, remember Rome wasn’t built in a day- start small , but start- or should I say- “Don’t talk -start – present something that shows you have made effort “. And never listen to nay Sayers- They say” no”, because they just don’t “KNOW”.

15-10-2015
I have invented a product for disposing off liquid waste from toilets in trains.
Ihave provisional patent No,5079/CHE/2013 d.11-11-2013 and it is published
after 18 months.
My invention is meant for railways.
I have complete prototype of my invention and I have fabricated a steel
tank as a part of my invention.

My requirements are as under:-

1) My invented product has to be tested practically for which I need electromagnets.

I am confident that my invention will be successful.

2) I need permission fro railways to install the product invented .

My invented product can be considered in two ways:-

a) As a corporate responsibility of railways to ensure cleanliness,
my product has to be tested and implemented.
b) To consider my invention as a business venture and any venture
capitalist can seek my invention as a huge business opportunity.

Merits of my invention:-

a) Ensures clean and tidy surroundings of railway tract and stations.
b) Eliminate corrosion of railway tracks.
c) Provide full time employment to several thousands of people in India.
d) To provide cost free raw material for poultry, piggery etc.
You can come and inspect my invention to have your own assessment.

Kindly contact me since I want to sell my invention to any interested venture capitalist.

For the first, I would like to introduce my self. My name is Irwan Kurniadi, 43 years old, Male, married, has not been had any children, and still been working at private company in Jakarta – Indonesia.
I got information by posting from Google about how to find the investor and I found your blogger which was offered funding with low interest rate ( 3% less) or share benefit (percentage) as an angel investor for build / start up a business.
Therefore, with humility I hereby apply for funds from you to startup my business plan.
The business that I’ve planned to build is supply a materials of corrosion protection for jetty’s steel pile, beside supply I also apply the material on pier to prevent the corrosion.
As we known that Indonesia is an archipelago country which was had many harbor as sea transportation port for trading, sea passenger transportation, navy, etc. So then, it should be need an appropriate maintenance for keeping the operational life time of the harbors. because the corrosion can be causing a damage and shorten the operational life time the jetty.
Until today, I have collected data from some damage of the dock to be repaired and I have received a request to repair some of the dock, and I also has estimated the price (supply and apply) and I ensure the business will give 20% profit for us from fixing any dock.

To make this happen, I have to build some sort of company for office and workshop and certainly needs funding. Therefore, I request the loan of $ 500,000 USD from you as the initial capital to run the business as well as for the purchase of materials and wages application.
I will pay the loan installments for 10 years with mild interest as you specify.
As references, I hereby submit my bio data, as follows:

For more information and discussions about business plans, please call me on my phone number above or my email address.
Thus the loan application I sent to you, and I sincerely hope that your generosity can provide this plea, finally I am very indebted to you and I am waiting for a good response.
(I would be glad to meet you and will show my business plan if you really want to help the funds to me)